Nafziger Economic Development (4th ed)

56	Part One. Principles and Concepts of Development
	10.5				36315	Real GDP Per Capita
						(1990 PPP $s)
	10				22026
	9.5	Italy	UK		US
					13360
			Netherlands
	9				8103
log)	8.5				4915
(Natural
	8				2981	Italy
Capita						Netherlands
Per	7.5				1808	United Kingdom
						United States
RealGDP
	7				1097
	6.5				665
	6				403
	5.5				245
	1500	1564	1836	1904	1998
			Years

FIGURE 3-1. World Leaders in GDP per Capita, 1500–1998 (1990 $PPP) (natural log).

Source: Maddison 2002:264, 276–279. See also Sharpe 2002:23.

Beginnings of Sustained Economic Growth

Historians hesitate to name a threshold period in history when real per-capita growth took off. Although there were periods of growth before the modern period, rapid, sustained growth was rare. Living standards remained at a subsistence level for the majority of the world’s population. The rapid, sustained increase in per capita GNP characteristic of modern economic growth began in the West (Western Europe, the United States, Canada, Australia, and New Zealand) 125 to 250 years ago. Industrialization and sustained economic growth had begun in Great Britain by the last half of the 18th century; in the United States and France in the first half of the 19th century; in Germany, the Netherlands, and Belgium by the middle of that century; and in Scandinavia, Canada, Japan (a non-Western country), Italy, and perhaps Russia, by the last half of the century.

China’s average economic welfare was more or less stagnant until the second half of the 20th century. In 1870, knowledgeable economists expected that India would be more economically and financially developed than Japan by 1970 (Goldsmith 1983:4–5). India, a British colony, possessed a unified currency, rudiments of a Western-style banking system, access to the British capital market, and British industrial and financial technology, whereas Japan, just emerging from feudalism, had a

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negligible modern sector, a chaotic currency, and no modern financial institutions. To be sure, from 1870 to 1913, just before World War I (1914–18), one of the more successful phases of capitalist growth, India’s economy grew, albeit slowly. However, India experienced negative growth from 1914 to 1945, a period of crisis in the world economy consisting of a depression bracketed by two world wars. Japan, by contrast, had virtually the fastest growth in the world during the period 1870 to 1950, notwithstanding its massive defeat during World War II.

The rest of Asia grew modestly during the one and one-half centuries before the mid-20th century. Africa, estimated to be close to the world’s average income in 0 C.E., remained the same or declined in living standards to 1820, but after that experienced modest per-capita growth until the middle of the 20th century. Latin America and Eastern Europe outpaced Asia and Africa from 1820 to 1950 (Maddison 2001:28, 126).

The West and Afro-Asia: The 19th Century and Today

Gross national income per capita for developed countries in the West in the first decade of the 21st century is roughly twelve times that of Afro-Asian low-income countries, if compared using international dollars using purchasing-power parity rates, and about 60 times that of these low-income economies in nominal U.S. dollars. The gap was not so great 130 to 140 years ago,2 since people could not have survived on one-twelfth the per capita income of the West in the late 19th century. Nobel laureate Simon Kuznets estimates a gap of 5:1 then (Kuznets 1971:23–29). Roughly speaking, at that time the West had an average real income higher than that of Africa today. Figure 3-2 shows, using a slightly different comparison, that the international spread in GDP per capita by region, the ratio of the highest region (Western offshoots: the United States, Canada, and Australia) to the lowest region (Africa), was 5:1 in 1870, 9:1 in 1913, and 19:1 in 1998. The Western or DC economic growth has been much more rapid during the past 130–140 years, and of course the DCs are adding to an already more substantial economic base.

Capitalism and Modern Western Economic Development

Why did sustained economic growth begin in the West? A major reason is the rise of capitalism, the economic system dominant there since the breakup of feudalism from the 15th to the 18th centuries. The relations between private owners and workers are fundamental to capitalism. The means of production – land, mines, factories, and other forms of capital – are privately held; and legally free but capital-less workers sell their labor to employers. Under capitalism private individuals operating for profit make production decisions.

Capitalist institutions had antecedents in the ancient world, and pockets of capitalism flourished in the late medieval period. For example, a capitalist woolen industry

2The starting point for examining modern economic growth is often 1870 because of complete nationalincome data for today’s DCs and a large number of LDCs since then (Pritchett 1997:4; Maddison 2001).

58 Part One. Principles and Concepts of Development

			International Spreads In GDP Per Capita
20
18
16
14
12
10									International
									Spreads In GDP Per
8
									Capita
6
4
2
0
1000	1200	1400	1600	1800	1830	1870	1900	1950	1998

FIGURE 3-2. International Spreads in GDP per Capita (1990 $PPP), Ratio of Highest Region to Lowest Region. Note: The regions are Western Europe, Western offshoots, Japan, Asia (excluding Japan), Latin America, Eastern Europe and former Soviet Union, and Africa. Source: Maddison 2001, p. 126, whose data are for 1000, 1500, 1820, 1870, 1913, 1950, 1973, and 1998. All other years are based on linear interpolation between these eight benchmark years.

existed in 13th-century Flanders and 14th-century Florence, but it died out because of revolutionary conflict between the workers and capitalists. Thus the continuous development of the capitalist system dates only from the 16th century.

Especially after the 11th century, the growing long-distance trade between capitalist centers contributed to the collapse of the medieval economy. As European trade activity expanded during the next few centuries, certain institutions facilitated the growth of modern capitalism. Among them were private property, deposit banking, formal contracts, craft guilds, merchant associations, joint stock companies (the precursor of the corporation), insurance, international financial markets, naval protection of trade vessels, and government support in opening markets and granting monopoly privileges for inventions.

At the same time, burgeoning industrialization and urbanization further weakened the feudal economy, an agricultural system based on serfs bound to their lord’s land. Ultimately these changes in trade, industry, and agriculture transformed the medieval economy into a new society fueled by capitalistic endeavors.

Before the 20th century, only capitalist economies were successful in large capital accumulation and in generating and applying a vast scientific and technical knowledge to production. Why was capitalism first successful in the West?

1.The breakdown of the authority of the medieval Roman Catholic Church, together with the Protestant Reformation of the 16th and 17th centuries, stim-

ulated a new economic order. Although Protestantism, like Catholicism, was

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ascetic, manifesting itself in the systematic regulation of the whole conduct of the Christian, the economic historian Max Weber, The Protestant Ethic and the Spirit of Capitalism,3 contended that the new Protestant ethic translated its “inner-worldly” asceticism into a vigorous activity in a secular vocation, or calling (in contrast to the “other-worldly” asceticism of the Catholic monastery). The Protestant ethic fostered hard work, frugality, sobriety, and efficiency, virtues coinciding with the spirit essential for capitalist development. Acceptance of the Protestant idea of a calling led to the systematic organization of free labor and gave a religious justification for unstinting work even at low wages in the service of God (and incidentally the employer). Chapter 12 questions Weber’s thesis, suggesting that Protestantism’s secularization or accommodation may better explain any association between Protestantism and capitalism. Still most economic historians would agree that the decline of the church’s all-encompassing power in political, economic, and ideological realms was necessary to free the spirit of capitalist development.

2.Between the 16th and 19th centuries, Western Europe witnessed the rise of strong national states that created the conditions essential for rapid and cumulative growth under capitalism. The nation-state established a domestic market free of trade barriers, a uniform monetary system, contract and property law, police and militia protection against internal violence, defense against external attack, and basic transportation and communication facilities – all of which fostered capitalism. Initially, absolute monarchs wrested power from feudal lords and town authorities and consolidated territory into large political and economic units – the nation-state. The nation-state was necessary for the larger markets and economies of scale of capitalist expansion. Eventually monarchy ceded power to the bourgeoisie, the capitalist and middle classes. Where an absolute monarch existed, the capitalist class, who enjoyed only a precarious existence under autocratic authority, ultimately stripped the monarch of power and installed representatives more favorable to their economic interests.

3.The declining influence of the church coincided with the Enlightenment, a period of great intellectual activity in 17thand 18th-century Europe that led to the scientific discoveries of electricity, oxygen, calculus, and so on. These discoveries found practical application in agriculture, industry, trade, and transport and resulted in extended markets, increased efficiency of large-scale production, and enhanced profits associated with capital concentration. Furthermore, the rationalism permeating the new science and technology meshed with the spirit of capitalist enterprise.

4.The philosophical rationalism and humanism of the Enlightenment, coupled with Protestantism’s spiritual individualism (the “priesthood of all believers”), emphasized freedom from arbitrary authority. In the economic sphere, this liberalism advocated a self-regulating market unrestricted by political intervention or state

3 1958; German original 1904–05.

60 Part One. Principles and Concepts of Development

monopoly. These views were tailor made for the bourgeoisie in its struggle to overthrow the old order.

5.Intellectual and economic changes led to political revolutions in England, Holland, and France in the 17th and 18th centuries that reduced the power of the church and landed aristocracy. The bourgeoisie took over much of this power. Economic modernization in Europe would probably not have been possible without these revolutions.4

6.Modern capitalism is distinguished from earlier economic systems by a prodigious rate of capital accumulation. During the early capitalism of the 16th and 17th centuries, the great flow of gold and silver from the Americas to Europe inflated prices and profits and speeded up this accumulation. Inflation redistributed income from landlords and wage laborers, whose real earnings declined, to merchants, manufacturers, and commercial farmers, who were more likely to invest in new and productive enterprises.5

Capitalism, as an engine for rapid economic growth, spread beyond Europe to the outposts of Western civilization – the United States, Canada, Australia, and New Zealand. Indeed, during most of the 20th century, capitalism has been more successful in the United States than in other Western economies.

However, modern industrial capitalism was established in the West at great human costs. Physical violence, brutality, and exploitation shaped its early course. In England and Belgium, wages dropped and poverty increased markedly during the accelerated industrial growth of the latter 18th and early 19th centuries. In both countries, it took a half-century before the absolute incomes of the poor reached pre–Industrial Revolution levels (Adelman and Morris 1978:245–273). Perhaps Charles Dickens best portrays the starvation, destitution, overcrowding, and death among the mid-19th century unemployed and working class. The lives fictionalized in Nicholas Nickleby, A Christmas Carol, and Oliver Twist were grim indeed. Dickens’s novels are an accurate portrayal of not only the English working class but of other Western workers during this time.6 Although these human costs may not be inevitable, similar problems have not been avoided by newly industrializing countries in subsequent periods. But despite these costs, even the late Marxist Maurice Dobb (1926) conceded that

4Although capitalism originated in the modern West, much of what contributed to its rise originated in other civilizations. For example, much of its scientific and technical content came from the Middle East and India, the philosophical from ancient Greece, and the legal and political from ancient Greece and Rome.

5Much of this section is from Dillard (1967:72–149); Dillard (1979:69–76); and North and Thomas (1970:1–17).

Neo-Marxists and dependency theorists (discussed in Chapter 5) argue that Western capitalism, through informal imperialism and late 19thand early-20th-century colonialism, developed at the expense of Latin America, Asia, and Africa, capturing their surplus (output above wages, depreciation, and purchases from other firms) through policies controlling their raw materials, markets, international trade, and planning. Most Western mainstream economists would not add imperialism as a contributor to Western capitalist success.

6 However, as Polak and Williamson (1993:229–230) indicate, rural poverty rates were higher than urban poverty rates in both England and France during the Industrial Revolution.

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capitalism has improved the levels of living for a large proportion of the Western population since the early 19th century.

Economic Modernization in the Non-Western World

Capitalism led to modern economic growth in only a few non-Western countries. Chapter 5 discusses the relative importance of barriers to capitalism extant in traditional societies, as well as the effects of colonialism and other forms of Western political domination on the slow development of non-Western economies. Irrespective of the cause, it is clear that most non-Western countries lacked the strong indigenous capitalists and the effective bureaucratic and political leadership essential for rapid economic modernization.

THE JAPANESE DEVELOPMENT MODEL7

Early capitalism’s fast growth. One notable exception was Japan, one of the five non-Western countries that escaped Western colonialism. Despite unequal treaties with the West from 1858 to 1899, Japan had substantial autonomy in economic affairs compared to other Afro-Asian countries.

Japan’s level of economic development was much lower than that of Western countries in the middle to latter 19th century. However, since 1867, when Japan abolished feudal property relationships, its economic growth has been the most rapid in the world.

Japan’s “guided capitalism” under the Meiji emperor, 1868 to 1912, relied on state initiative for large investments in infrastructure – telegraphs, postal service, water supply, coastal shipping, ports, harbors, bridges, lighthouses, river improvements, railways, electricity, gas, and technical research; for helping domestic business find export opportunities, exhibit products and borrow abroad, establish trading companies, and set marketing standards; for importing machines sold on lenient credit terms to private entrepreneurs; for laws encouraging freedom of enterprise and corporate organization; for organizing a banking system (with the central Bank of Japan); for sending students and government officials for training and education abroad; and (in the absence of foreign aid) for hiring thousands of foreigners to adapt and improve technology under local government or business direction.

In the late 19th century, government initiated about half the investment outside agriculture but sold most industrial properties, often at bargain prices, to private business people. Additionally government aided private industry through a low-wage labor policy, low taxes on business enterprise and high incomes, a favorable legal climate, destruction of economic barriers between fiefs, lucrative purchase contracts, tax rebates, loans, and subsidies. Japan acquired funds for industrial investment and assistance by squeezing agriculture, relying primarily on a land tax for government revenue. From the state-assisted entrepreneurs came the financial cliques or combines (zaibatsu) that dominated industry and banking through World War II. Keiretsu, formed after World War II, refers to groups of affiliated companies loosely

7 This section is based on Nafziger (1995) and Nafziger (1986:1–26).

62Part One. Principles and Concepts of Development

organized around a large bank, or vertical production groups consisting of a core manufacturing company and its subcontractors, subsidiaries, and affiliates (Hsu 1994:198–99).

Nevertheless, unlike the contemporary Indian government, the Meiji government retained small industry, compelling the zaibatsu to provide technical advice, scarce inputs, and credit and encouraging small firms to take cooperative action. Creating small industry from scratch is not as effective as the Japanese approach of maintaining and upgrading workshop, handicraft, and cottage industry from an earlier stage of development.

Meiji Japan did not stress large leaps to the most advanced state of industrial technology available, but step-by-step improvements in technology and capital as government departments, regions, firms, and work units learned by doing. In the 1870s, this meant technical and management assistance and credit facilities to improve and increase the scale of crafts and small industry from the feudal period, causing less social disruption, as small industry’s environment was not alien.

Regarding Japan’s technology acquisition, Lawrence G. Franko (1983:23) contends that

The Japanese are without doubt the world’s champion importers of “other people’s” technology. Unlike other industrial nations which may have forgotten how much of their technological development was in fact based on seeking out, stumbling upon, or helping themselves to foreign discoveries and innovations, Japan has continuously sent its sons to be educated abroad and then to live or travel abroad to search out ways of catching up with or surpassing the West.

The fact that today Japan probably has one of the highest mass standards for primary and secondary schools in the world, and shares underlying national values, is no accident. Japan’s rulers laid the foundation in the late feudal period, when Japan’s primary enrollment rate was higher than the British, and in 1872, when a national system of universal education stressing scientific and technological education was established.

Moreover from 1868 to World War II, the Japanese had a policy (first forced and later chosen) of multilateral, nondiscriminatory foreign trade outside their empire (1904–45). Unlike today’s LDCs, Japan did not discriminate against exports. The increased tariff protection in the first quarter of the 20th century, which reduced the price of foreign exchange, was offset by government export promotion, which brought the exchange rate close to a market-clearing rate (see Chapter 17 on foreign exchange rates). From 1868 to 1897, the Japanese yen, on a silver standard that declined relative to gold, chronically depreciated vis-a`-vis the U.S. dollar, maintaining Japan’s competitiveness.

Today’s international economic conditions are not so favorable to LDC export expansion. The most rapidly expanding LDC manufactured exports during the 1970s through the early 1990s were textiles, clothing, footwear, and simple consumer goods requiring widely available labor-intensive technology. But competition from other aspiring newly industrial exporting countries is more severe than it was for Meiji

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Japan. Still, LDCs could benefit from the Japanese approach of using international competition and market-clearing exchange rates to spur exports.

The end of Japan’s economic miracle. In 1982, University of Washington Professor Kozo Yamamura (1982:99–117) was one of the earliest economists to point out the end of Japan’s “miracle,” warning that Japan had exhausted its three decades of fast growth from catch-up, benefiting from internal and external economies of scale and learning by doing from rapid growth in investment and adapting advanced technology from more advanced DCs (see DC convergence later). Japan’s industrial policy, spearheaded by the Ministry of International Trade and Industry, still relied on cartels and restrictions to limit imports even after joining the General Agreement on Tariffs and Trade (GATT), the global organization administering rules of conduct in international trade before 1995, when GATT was replaced by the World Trade Organization (WTO). The informal protection from cartels, administrative guidance, and subsidies increased domestic costs to the detriment of Japan’s otherwise efficient export sectors. These high costs, together with a keiretu-laden banking system impaired by a 10-percent ratio of bad debts to GDP in 1990, burst the financial euphoria of the 1980s, and were followed by stagnation from 1992 to 2003 (Katz 1998; Katz 2003). Many doubt that LDCs, once having provided protection for the catch-up phase, would have the strength to counter the special interests comparable to Japan’s Iron Triangle – politicians, the bureaucracy, and big business – that became more venal and incestuous beginning in the early 1970s. Japan’s growth collapse in the 1990s is another reason not to blindly follow its or any other country’s model of economic growth without asking how that model needs adjustment when transferred to another country and culture.

Moreover, although a contemporary LDC can learn useful lessons from the early Japanese model, these lessons are limited because of Japan’s historically specific conditions and because aspects of the 1868–1937 Japanese approach also contributed to pathologies in growth, such as zaibatsu concentration, income inequality, labor union repression, militarism, and imperialism. These pathologies were not reduced until military defeat in 1945 was followed by land, educational, demilitarization, labor union, antimonopoly, monetary stabilization, constitutional, and other reforms undertaken by the U.S. occupational government, supported by the revolutionary momentum of the Japanese populace. This series of events associated with military devastation is not to be recommended or likely to accelerate economic development and democratize the political economy in LDCs as it did in Japan.

THE KOREAN–TAIWANESE MODEL

Despite Asia’s financial crisis, 1997–99, the fastest growing developing countries are the Asian tigers or newly industrializing countries (NICs) of East and Southeast Asia – South Korea, Taiwan, and Singapore, and Hong Kong, a part of China since 1997. Both Singapore and Hong Kong have been prosperous entrepot city-states, providing trade and financial links for their hinterlands, for other parts of Asia, and between Asia and the external world. As city-states, however, they are not likely to

64Part One. Principles and Concepts of Development

serve as models for more populous nation-states. Thus, we concentrate here on the two remaining Asian tigers, Taiwan and Korea, which have both enjoyed a real per capita growth rate of more than 6 percent since 1960 and graduated to high-income economies in the years since 1990.

The model of Korea and Taiwan is similar to that of Japan, perhaps unsurprisingly for two countries that were also a part of greater Chinese civilization for centuries and that were Japanese colonies from about the turn of the 20th century through World War II. Similar to Japan, the governments of Korea and Taiwan systematically intervened to further economic development, building infrastructure, providing tax incentives and subsidized credit for export manufacturing and other selected industries,8 investing heavily in primary education and other human capital, and maintaining macroeconomic stability during external shocks (for example, from oil price increases in 1973–74 and 1979–80 and American dollar depreciation in the late 1980s), thus restraining inflation and avoiding external debt crises (World Bank 1993a; Amsden 1994:627–633; Kwon 1994:635–644; Lall 1994:645–654; Yanagihara 1994:663–670). A major difference between the two was that Korean government policies were partial to private conglomerates such as Hyundai, Lucky-Goldstar, and Daewoo, whereas Taiwan emphasized aid and the dissemination of research and technology to small-to medium-sized private and state-owned enterprises (Rodrik 2000:195–201; Noble and Ravenhill 2000:80–107).

Korea and Taiwan, also like Japan, have had a high quality of economic management provided by the civil service, with merit-based recruitment and promotion, compensation competitive with the private sector, and economic policy making largely insulated from political pressures. According to Harvard’s Dani Rodrik (2000:195– 201), Korea and Taiwan had been hampered by a coordination failure before the 1970s. Labor skills, technologies, and intermediate inputs or capital goods require a large-scale movement of resources to benefit from internal and external economies of scale and well-educated workers at low cost to be competitive internationally. In the 1970s, the Taiwanese and Korean states provided “big push” polices (see Chapter 5) to coordinate the mobilization of resources essential for economic transformation and a takeoff into sustained growth.

Both Asian tigers have combined creating contested markets, where potential competition keeps prices equal or close to average price, with business-business and government-business cooperation. In Korea, this had meant interfirm and publicprivate sharing of information alongside competition by a few, but usually evenly matched, firms in economic performance, especially in exports. The World Bank uses the following metaphor: Just as adults may prefer to organize party games to letting children do as they please, so running the economy as the Japanese, Koreans, and Taiwanese do as contests with substantial rewards, clear, well-enforced rules, and impartial referees (such as central banks and ministries of finance) may be preferable to laissez-faire (government noninterference) (World Bank 1993a:93–95).

8Korea also had state-owned enterprises (SOEs), whose management was autonomous from the state. For example, management decisions in Korea’s first steel SOE, Pohang Iron and Steel Company, established in 1968, were more independent and less bureaucratic than in SOEs in India and Brazil (D’Costa 1999:M2–M16).

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Both countries have pursued a dual-industrial strategy of protecting import substitutes (domestic production replacing imports) and promoting labor-intensive manufactures in exports, although since the 1960s, they have facilitated a shift in the division of labor to more capitaland technology-intensive exports (Ohno and Imaoka 1987:310–323; Bradford 1987:299–316). Yet Korea established a timetable for international competitiveness that provided performance standards for each industry assisted. Moreover, the Koreans and Taiwanese did not cling to a given nominal exchange rate in the face of continuing inflation, as many African and Latin American countries did, but depreciated their currencies when necessary. Additionally, like early-20th-century Japan, the two tigers subsidized exports to offset tariff protection. All in all, Korea and Taiwan avoided the excessive real currency appreciation of many other LDCs, so that like early Japan, they did not discriminate against exports (World Bank 1993a:21–22, 113–115).

During the first 25 years after World War II, industrialization in Korea and Taiwan benefited from United States aid, capital inflows, and rapidly growing demand for manufactured goods in Asia. Yet aid as a percentage of GDP in early post–World War II Taiwan (6 percent in 1951–61) was even lower than the same percentage in Africa recently (8 percent in 1987) (Brautigam 1994:111–138).9 Since the 1970s, the two tigers have been closely linked economically and geographically to Japan and other high-performing Asian economies, facilitating trade and investment flows. Beginning in late 1985, when the U.S. dollar began devaluing relative to the Japanese yen, Japanese companies have tried to retain their international price competitiveness in manufacturing by organizing the Asian borderless economy. This Japanese-led system, which encompasses a new international division of knowledge and function, selected more sophisticated activities including research and development-intensive and technology-intensive industries for the four tigers, while assigning the less sophisticated production and assembly, which use more standardized and obsolescent technologies, to China and three members (Indonesia, Malaysia, and Thailand) of the regional economic group, the Association of South East Asian Nations (ASEAN).10

In both countries, government-owned and -controlled financial institutions provided cheap investment funds for the private sector. Korea and Taiwan established long-term development banks and other credit institutions to direct development, applying commercial criteria to select and monitor projects. The countries also kept interest rates low, especially for exporters, providing capital from the high-saving households (much from postal savings) to firms at subsidized rates (World Bank 1993a:16–20, 42–43, 133–134, 220–221).

The Koreans and Taiwanese, like the Japanese, borrowed substantial technology from abroad, often increasing productivity while learning to meet foreign standards for manufactured exports. The two NICs overcame imperfections in the market for knowledge through the purchase of new equipment to acquire technology,

9Korea probably received more aid as a proportion of GNP than Taiwan during this period. Over 80 percent of Korea’s imports in the 1950s were financed by U.S. assistance (Jazairy, Alamgir, and Panuccio 1992:11).

10Shojiro (1992:11–37). The Asian borderless economy and product-cycle model are discussed further in Chapter 17.